Turbo Corporation (a U. S.-based company) acquired merchandise on account from a foreign supplier on November 1, 2017, for 100,000 markkas. It paid the foreign currency account payable on January 17, 2018. The following exchange rates for 1 markka are known:

November 1, 2017 $0.754
December 31, 2017 0.742
January 15, 2018 0.747

a. How does the fluctuation in exchange rates affect Turbo's 2017 income statement?
b. How does the fluctuation in exchange rates affect Turbo's 2018 income statement?

a. It results in a gain on foreign exchange of $1,200

b. It results in a loss on foreign exchange of $500

Explanation:

The accounting standard related to foreign exchange is IAS 21 and it requires that financial assets and liabilities in the balance sheet are recognized at the spot rate and revalued at year end using the closing rate with the difference between the amounts at transaction date and year end recognized as a gain/loss in the income statement.

Since the item was purchased on account, the inventory is not a financial asset and will thus not be revalued. However, the accounts payable will be revalued.

The entries posted on purchase would have been debit inventory and credit accounts payable.

On November 1, 2017

1 markka = $0.754

100,000 markka = $75,400

when the rate changes to $0.742,

100,000 markka = $74,200

The difference

= $75,400 - $74,200

= $1,200

There has been a reduction in the liability by this difference hence

Debit Accounts payable $1,200

Credit Foreign exchange gain $1,200

January 15, 2018 where the rate becomes $0.747,

100,000 markka = $74,700

The difference then becomes

= $74,200 - $74,700

= ($500)

This is an increase in the liability hence

Debit Foreign exchange loss $500

Credit Accounts payable $500

Explanation:

Turbo corporation acquiring a merchandise on account from a foreign supplier means that Turbo will have to pay for goods purchased in foreign currency at the prevailing exchange rate. and such transaction will be recorded as debit inventory and credit accounts payable

amount of markkas bought = 100000

A) how does the fluctuation in exchange rate affect 2017 income statement

exchange rates for 2017:

November 1 , 2017 = $0.754

December 31, 2017 = $0.742

for November 1 2017 = 100000 * 0.754 = $75400

for December 31 2017 = 100000 * 0.742 = $74200

the difference would be = ( $75400 - $74200 ) = $1200

in the income statement  it will be recorded as credit foreign exchange gain= $1200 and debit accounts payable = $1200  because their was reduction in liability ( foreign exchange rate )

B ) how does the fluctuation affect 2018 income statement

December 31, 2017 = $0.754

January 15, 2018 = $0.747

for December 31, 2017 = 100000 * 0.742 = $74200

for January 15, 2018 = 100000 * 0.747 = $74700

difference = ( $74200 - $74700 ) =  - $500

this is an increase in liability because the exchange rate increased between December 31 2017 to January 15 2018

this will be recorded as Debit foreign exchange loss $500 and credit accounts payable$500

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